A new government should tear up "ineffectual" lending agreements with Britain's taxpayer-owned banks and force them to lend billions of pounds more to small and medium sized businesses, Liberal Democrat Treasury spokesman Vince Cable said today .

Agreements signed by the government last year with Royal Bank of Scotland and Lloyds Banking Group were poorly implemented and had failed to generate the funds needed for British business to get back on its feet, he said.

In a move to distance himself from rival parties ahead of the election, Cable argued banks must put aside any thoughts of returning to the private sector, possibly for 10 years, while they perform a job for the wider economy.

"Restrictions on lending to sound companies by all banks is preventing a sustained economic recovery and thereby compounding the risk of growing bad debts," he said. "Behaviour which appears sensible to individual banks is disastrous when pursued collectively."

Bonuses should also be effectively banned from the banking industry and banks broken up, he said, in a clear message to Barclays and HSBC that they would be forced to separate their investment banking arms from less racy retail operations.

The government has urged banks to increase lending, but has so far refused to loosen other requirements that could make funds available.

Cable argued concerns among nationalised and semi-nationalised banks that they should shun risky lending in favour of building up their reserve capital were "largely irrelevant" because government guarantees meant they "cannot go bust".

Treasury officials have already admitted banks will miss lending targets. A study by the Institute of Directors highlighted that six out of every 10 businesses was being "starved of capital".

Those companies able to borrow were being asked to provide extra security and pay large arrangement fees and high interest rates, Cable said.

Without government intervention and the use of state-owned banks as tools of government policy, the UK risked slipping back into a long recession that would prove as disastrous over the longer term for bank profits as it would for the economy.

Last week Tory shadow chancellor George Osborne proposed selling shares at a discount in RBS and Lloyds at the earliest opportunity. He put forward a plan for savers to buy shares in the banks after their share prices had recovered sufficiently for the government to recover its own shareholdings.

Cable ridiculed the plan, which he said would perpetuate the current obsession among banks to make profits, pay dividends to shareholders, horde cash and drive up their share prices.

Taxpayers should hang on to their shares for at least 10 years and following the Swedish model maintain a sizeable minority holding of 10% or 20%, he said.